J&J's nearly $17 billion offer to buy a heart pump maker goes right to why we own it

Published Tue, Nov 1 20221:41 PM EDT

Johnson & Johnson 's (JNJ) $16.6 billion deal to buy heart pump maker Abiomed (ABMD) will bolster its pharmaceutical and medical device business ahead of J & J's plans to separate its consumer division into a separate company. The Abiomed acquisition is set to close at the end of the first quarter of 2023. The spin-off of J & J's consumer business, including such brands as Band-Aid and Tylenol, is expected in November of next year. Bottom line The new standalone J & J consumer company will be called Kenvue . The break-up will allow the remaining company, which will keep the Johnson & Johnson name, to increase its focus on its Biopharmaceutical and Medical Device Innovation and Technology businesses. The Abiomed transaction is in line with this initiative and will strengthen Johnson & Johnson's ability to address the unmet need for innovation in heart failure and recovery while accelerating long-term sales and earnings growth. We like the transaction as it strengthens the core of our investment thesis — an intensified focus on the fastest-growing segments of JNJ, specifically MedTech in this case. As a reminder, J & J's MedTech unit reported operational growth of 8.1% globally in the third quarter. That's certainly a respectable growth rate, but not quite the 10% to 14% sales growth (up 13% to 17% in constant currency basis) that Abiomed guided to for fiscal year 2023, when the company released fiscal first-quarter 2023 numbers back in early August. Put simply, the addition of Abiomed will serve to accelerate the growth rate of J & J's MedTech unit and should, in theory, lead to a higher valuation as investors tend to reward growth with multiple expansion. The Abiomed transaction, which will be financed with J & J's cash on hand and short-term financing, is expected to be negative-to-neutral for earnings next year. In 2024, J & J expects the acquisition to add roughly 5 cents to its per-share earnings and to be what the company describes as "increasingly accretive thereafter." Valuation While the valuation being paid is not cheap at roughly 16-times fiscal year 2023 Abiomed sales estimates, Johnson & Johnson has the financial capacity to get it done without taking on too much debt. The amount paid represents a little over half of J & J's expected earnings before interest, taxes, depreciation, and amortization (EBITDA) for fiscal year 2022. In the long-term, we believe the transaction will prove to be a better investment than just sitting on cash. It will create greater returns than any interest incurred on the debt, given that Abiomed's offerings address a greater than $35 billion market opportunity in the U.S alone . Heart failure, which is the end result of all untreated cardiovascular disease, is the primary cause of hospitalization for those over the age of 65 in the U.S., and the No. 1 cause of death in America. In a call with investors following the announcement, J & J management also affirmed that despite the acquisition, the company has "the flexibility to continue to pursue multiple priorities concurrently investing in R & D, pursuing value enhancing acquisitions like this one, and returning capital to shareholders through our dividend and share repurchases when appropriate." Use of cash Acquisitions are generally done via an exchange of cash, stock, or a combination of the two. The risk/reward nature of a deal can shift based on the form of payment. For example, an all-stock offer allows both parties to participate in the upside but also share in the risk should the integration not have the desired effect of creating a stronger business and creating additional value. A cash offer on the other hand means that the buyer — in this case Johnson & Johnson — is taking on all the risk but will keep 100% of any realized value creation. A decision like this, to lay out nearly $17 billion, or $380 per Abiomed share, upfront, can therefore speak to management's confidence in the opportunity this acquisition presents. Sure, J & J is taking on all the integration risk — but if successful, its shareholders will realize 100% of the reward without the share dilution that would otherwise result from a payment in stock. Fortunately, Johnson & Johnson has one of the best balance sheets in the world. After the announcement before-the-bell Tuesday, J & J shares fell less than 1% while Abiomed stock surged more than 50%, in line with that upfront per-share premium. Contingent value Part of the deal does also allow Abiomed shareholders to realize additional per-share in cash should certain commercial and clinical milestones be achieved. That's thanks to a non-tradeable contingent value right (CVR) they are receiving as part of the deal. The breakdown on the CVR is as follows. According to the press release, $17.50 per share would be awarded "if net sales for Abiomed products exceeds $3.7 billion during Johnson & Johnson's fiscal second quarter of 2027 through fiscal first quarter of 2028." If, however, this target is not met but is "subsequently met during any rolling four quarter period up to the end of Johnson & Johnson's fiscal first quarter of 2029," then $8.50 per share will be awarded. Additionally, $7.50 per share awarded "upon FDA premarket application approval" of the use of Abiomed's Impella products in patients with segment elevation myocardial infarction (STEMI) "without cardiogenic shock by January 1, 2028." And, $10 per share payable "upon the first publication of a Class I recommendation for the use of Impella products in high risk [percutaneous coronary intervention] PCI or STEMI with or without cardiogenic shock within four years from their respective clinical endpoint publication dates, but in all cases no later than December 31, 2029." Ultimately, while these do represent further potential payments from J & J to Abiomed shareholders, they are far out in the future and would be well worth it should the milestones required to unlock the payments be achieved. (Jim Cramer's Charitable Trust is long JNJ. See here for a full list of the stocks.) As a subscriber to the CNBC Investing Club with Jim Cramer, you will receive a trade alert before Jim makes a trade. Jim waits 45 minutes after sending a trade alert before buying or selling a stock in his charitable trust's portfolio. If Jim has talked about a stock on CNBC TV, he waits 72 hours after issuing the trade alert before executing the trade. THE ABOVE INVESTING CLUB INFORMATION IS SUBJECT TO OUR TERMS AND CONDITIONS AND PRIVACY POLICY , TOGETHER WITH OUR DISCLAIMER . NO FIDUCIARY OBLIGATION OR DUTY EXISTS, OR IS CREATED, BY VIRTUE OF YOUR RECEIPT OF ANY INFORMATION PROVIDED IN CONNECTION WITH THE INVESTING CLUB. NO SPECIFIC OUTCOME OR PROFIT IS GUARANTEED.

Johnson & Johnson headquarters in New Brunswick, N.J.

Mel Evans | AP